{"id":46970,"date":"2015-11-30T00:17:32","date_gmt":"2015-11-29T23:17:32","guid":{"rendered":"http:\/\/beta.next-finance.net\/note\/on-the-impact-of-brexit-on-sterling\/"},"modified":"2019-12-31T00:20:51","modified_gmt":"2019-12-30T23:20:51","slug":"on-the-impact-of-brexit-on-sterling","status":"publish","type":"post","link":"http:\/\/beta.next-finance.net\/en\/note\/on-the-impact-of-brexit-on-sterling\/","title":{"rendered":"On the impact of Brexit on sterling"},"content":{"rendered":"

As yet, sterling appears not to have reacted to the looming referendum on the UK\u2019s continued membership of the
\nEuropean Union. Over the short to medium term, however, the currency should end up reacting negatively, so great
\nis the fallout for the British economy. In particular, one would expect the volatility displayed by sterling to pick up at
\nthe start of 2016, bearing in mind that opinion polls are very tight. Before considering the effects of the referendum
\non the British currency, we set out the context, the reforms proposed by the British government, key dates, and,
\nespecially, the possible impact on the British economy.<\/p>\n

In reaction to the emergence of the UK Independence Party (UKIP), David Cameron decided in January 2013 to hold
\nan In\/Out Referendum to preserve the unity of the Conservative Party. Since the creation of the European Union,
\nthe UK has been a rather reluctant partner, opting out of the single currency and the Schengen agreement. The
\nsovereign debt crisis and the influx of migrants have revived the debate over the UK\u2019s continued EU membership. A
\nreferendum should be held before the end of 2017. It is very likely that it will be held in Q3 2016, not in 2017 as
\nthere are general elections in France and Germany.<\/p>\n

So far, David Cameron has written a letter to the European Council President setting out proposed reforms requiring
\nthe EU to change its founding treaties. If there is agreement over the proposed reforms, the British Prime Minister
\nindicated in the letter that he was ready to campaign for continued EU membership.<\/p>\n

There are four main areas where the UK is seeking reform:<\/p>\n

1. Economic governance<\/em>: David Cameron wants recognition that the EU has more than one currency. He also wants
\nEuro-outs to have a say in developments within the Eurozone that affect all Member States, so as to preserve
\nthe positions of Euro-outs within the EU.<\/p>\n

2. Competitiveness<\/em>: the British Prime Minister is seeking a scaling back of unnecessary legislation to improve the
\ncompetitiveness of EU Member States. He also proposes adopting a new trade strategy, including unfettered
\ntrade deals with the US, China, Japan and ASEAN.<\/p>\n

3. Sovereignty<\/em>: David Cameron wants to end the UK\u2019s obligation to work towards an \u201cever closer union\u201d as set out
\nin the Rome Treaty. He wants to enhance the role of national parliaments, notably with a new arrangement
\nwhereby groups of national parliaments, acting together, can stop unwanted legislative proposals at EU level.<\/p>\n

4. Immigration<\/em>: the Prime Minister\u2019s priority is to introduce a 4-year restriction on access to in-work benefits in the
\ncase of people coming to the UK from the EU.<\/p>\n

Following the announcement of these proposals, a number of members of the European Commission have already
\nsaid that certain reforms were \u201chighly problematic\u201d, which suggests that negotiations will be tough at the December
\nmeeting of the European Council.<\/p>\n

Key dates and timetable:<\/strong><\/p>\n

\"key_dates_and_timetable.jpg\"<\/a><\/p>\n

The cost of a British exit on the British economy is still uncertain.<\/strong> The risk is that foreign investors and British
\nenterprises would face a prolonged period of uncertainty, which could be very costly. An erosion in investor and
\nbusiness confidence would lead to a significant fall in investment. The impact on trade exchanges would be
\nconsiderable. The European Union is the UK\u2019s biggest trade partner, accounting for 45% of exports and 53% of
\nimports. If the Out campaign prevails, the country would be excluded from the trade agreement with the EU. The
\nWTO could impose customs duties on British goods and services, significantly increasing cost of trade. At
\nemployment level, a British exit would make the UK less attractive for migrants. The UK labour market would
\ntherefore be deprived of a significant source of labour supply. The existence of an abundant workforce because of
\nthe migrants has contributed to holding back wage growth and inflation. This situation has checked the rise in
\nsalaries in recent years, hence in inflation.<\/p>\n

Since September, the probability of a UK exit from the European Union has increased according to
\nopinion polls, but without this having a significant impact on sterling.<\/strong>
\n\"eu_referendum_neck_and_neck2.jpg\"<\/a><\/p>\n

Whatever the outcome of the referendum, it will affect sterling. If there is a British exit, there will follow a period of
\nuncertainty for investors (impact on 1-year volatility). Although not entirely similar, the referendum on Scottish
\nindependence saw sterling slump by 4%, but not before the fortnight preceding the vote. This time, however, the
\neffects will be felt far earlier when it comes to the British economy and currency as fallouts would be greater, possibly
\nleading to a breakup of the UK, if Scotland opts to stay in the European Union.<\/p>\n

Our view is that the UK will vote to remain in the European Union. However, sterling will be under pressure throughout
\nH1 2016, particularly if the polls remain tight, as this would stoke uncertainties, hence capital outflows. The GBP\/USD
\ncould correct to 1.46 in H1 2016, which suggests that 1-year RR 25D also have downside potential in the short term.<\/p>\n

They currently stand at -1.69 compared with -2.89 in March 2015.
\nSterling will not recover until the end of 2016, heading towards 1.52 post-referendum, with the help of the Bank of
\nEngland, which can be expected to kick start its monetary tightening in reaction to the expected rebound in inflation
\n(disappearance of base effects). In coming months, we expect 1- and 2-year implied volatility to pick up because of
\nthe uncertainties over the outcome of the In\/Out referendum that could be held end-2016, or possibly in 2017.<\/p>\n

\"gbpusd_vol_1y_bis.jpg\"<\/a><\/p>\n

If voters reject a British exit by a large majority, the GBP\/USD\u2019s rebound will be more substantial, the pair heading
\ntowards 1.55, inasmuch as this would strengthen the UK\u2019s position in the European Union and amongst investors. If
\nthe vote is for a British exit, the GBP\/USD will correct further given uncertainties over trade relations as well as at
\neconomic and political levels. If this scenario unfolds, the GBP\/USD could pull back post-referendum towards 1.40 at
\nthe end of 2016.